The bull case for Nordstrom's pricey Trunk Club acquisition

In the days since Nordstrom officially confirmed its acquisition of Trunk Club, I’ve had a surprising number of people ask me if I think the deal “makes sense.” Many of them, even if willing to acknowledge the synergies between the two companies, balk at the reported $350 million price.

The skeptic’s case goes as follows (and I’ve heard variations of the following from several smart people in and around the ecommerce sector). Trunk Club is hardly a novel or proprietary concept and Nordstrom could easily duplicate the experience using its own brand and infrastructure. Moreover, the men’s apparel category is far smaller than the women’s and doesn’t merit such a big bet. Finally, with the startup optimistically projecting $100 million in 2014 revenue with still five months left in the year, and barely any profit falling to the bottom line, the rumored price is simply too rich to make sense.

For example, retail and commerce banker Elliott Darvish at The Sage Group said almost exactly that in an email that read:

Unless I’m missing something obvious, that seems like an absurd amount—I have tried Trunk Club, it’s far from a novel concept. I don’t see why Nordstrom can’t just hire a merchandiser and have them fill a box of clothes for men themselves...

I do see value in the “men hate to shop,” because I seriously dislike shopping. That said, the men’s e-commerce market is significantly smaller than women’s and I still don’t see why Nordstrom would take such a gamble on a smaller market.
Call me an optimist, but I’m a big fan of this deal, and have been since it was rumored a month ago. As I see it, Trunk Club and Nordstrom each offer things that would be costly and slow for the other to duplicate on their own. At a high level, Nordstrom gets access to a team of experienced personal stylists, an audience of tens of thousands of loyal (male) users – that most likely aren’t regularly shopping in Nordstrom as it is – ecommerce expertise, and male-oriented branding/marketing expertise, all in a package that is profitable despite operating with the limited resources of a startup.

Indirectly, Trunk Club will also provide Nordstrom with a source of foot traffic to its brick and mortar locations as ecommerce and shop-at-home users visit stores to return, exchange, and alter their purchases. It is a phenomenon that has proven to be true for the company’s last big ecommerce acquisition, Hautelook, and for Bonobos, in which Nordstrom is an investor and carries its products online and in-store. The try-at-home model could also help Nordstrom target non-coastal, non-urban markets in the Midwest and South, outside of its existing store footprint.

Looking at the impacts of Nordstrom on Trunk Club, it’s easy to see how this quickly becomes a far larger and more efficient business. The sheer scale of the brick and mortar giant’s supply chain operation means better rates and likely more efficient operation for things like warehousing and shipping. Also, returns are the scourge of nearly all ecommerce operations. While Trunk Club’s try-at-home model is set up to see a particularly high level of returns, saving on shipping and having an outlet channel (Nordstrom Rack) for damaged items will only improve the company’s margins.

Furthermore, while Trunk Club already offers an impressive diversity of brands (approximately 100), a deeper relationship with Nordstrom will no doubt help broaden this selection and will likely mean better terms with the company’s existing vendors. The company’s monthly boxes also represent an attractive new channel for Nordstrom to sell its own private label merchandise. Add to these better merchandise and supply chain economics Nordstrom’s large existing customer base and marketing reach, and it’s a fair bet that Trunk Club’s subscriber count will grow an order of magnitude as a result.

As far as the reported $350 million valuation, it’s hard to dissect that number without access to more specific details like the deal structure – how much cash, how much equity, and what, if any, are the performance-based terms? – and without a clear understanding of Trunk Club’s financials. Going by what’s out there, we can make some assumptions.

Trunk Club’s Spaly tells the New York Times that his company is “on track to double [its] revenue to slightly more than $100 million this year,” and further describes the business as barely profitable. Internet Retailer estimates the company’s 2013 sales at just $21 million. Assuming that figure was slightly low, and that Trunk Club is growing at somewhere between 100 and 200 percent per year, that’s a tremendous growth rate for a company of this size and would earn it a better than normal revenue multiple.

Given this growth rate and being that we’re a little more than half way through the year, it would be generous to assume that the company’s last 12 months (LTM) revenue is $50 million. At a $350 million valuation, the company would have earned a LTM multiple of at least 7X, placing it at the high end of the industry standard 2-4X multiple, according to Darvish. But given the above estimated growth rate and the impact that Nordstrom’s operating scale will have on the already profitable business, it’s not unrealistic that the acquirer would be willing to pay a premium. And again, we’re not sure how that price, if accurate, was structured. Hopefully we’ll learn more to that effect in Nordstrom’s August 14 earnings report.

Tempering this enthusiasm slightly, Darvish says:

The $100 million is projected 2014 revenue. Who knows how they will fare in the final 5 months of 2014? They reportedly had $21 million of sales in 2013, hard to see that type of growth for ANY middle-market e-retailer year over year...

Based on the e-commerce deals we’ve looked at in the last several years, it’s not unusual to see valuations in the 2-4X LTM revenue range. There is really an M&A and valuation frenzy right now and as evidenced by Trunk Club / Nordstrom acquisition and Citrus Lane / Care.com at a 5.4x LTM revenue multiple, the range may be moving up.
As for the argument that Nordstrom could simply duplicate Trunk Club’s model on its own, shipping curated boxes of apparel to its customer to try on at home, I say bullshit. Yes, Nordstrom could create a similar service, but the idea that it would be easy or would result in a sustainable and valuable offering is a major unknown. By acquiring Trunk Club, rather than looking to rip it off, Nordstrom gains an established brand with a dedicated and experienced team at the helm. If you want to have a Trunk Club-style offering long term as a way to best serve today’s modern male consumer, buying Trunk Club is definitely the best way to get it.

The men’s fashion market may not be as big as the women’s, but it's broken and it’s commanding more and more attention of late from retailers. The male consumer has grown more sophisticated and is spending more than ever before, and the success of brands like Trunk Club and Spaly’s prior startup Bonobos are evidence of this fact. Moreover, there is far less competition and more greenfield in the still nascent men’s market than there is in the oversaturated women’s space. Nordstrom obviously sees Trunk Club as an attractive avenue for reaching this underserved consumer audience.

Nordstrom has proven itself one of the most aggressive acquirers in the traditional brick and mortar fashion world. There’s still a lot we don’t know in terms of the terms of the Trunk Club deal, and it will be at least a year or two before we can meaningfully assess the success of the acquisition. But for my money, this deal makes a ton of sense from both the buyer’s and seller’s perspective.

It’s always a tough decision as an entrepreneur to sell or to stay the course and build big. But in the fashion commerce category in particular, scale is such a huge advantage that it can be particularly enticing to join the ranks of a more established operation. It’s incredibly hard to make that leap from serving thousands of customers to millions, or from generating tens of millions of dollars in sales to hundreds of millions.

Between Trunk Club and Bonobos (where he was an early founder), Spaly has proven that he is strong at early brand building and business model innovation. But, if he has a weakness, it may be the day to day block and tackling that’s required to manage and scale a late-stage commerce operation. Then again, he's done something right to get Trunk Club to an exit. Regardless, the prospect of having a bit of backup in this regard obviously proved to be enticing. And for Nordstrom, the idea of adding a unique men’s commerce service with an established audience and an experienced team was worth spending for.

Spaly's former partner Andy Dunn just doubled down at Bonobos, raising a large growth round and committing to building for an IPO. In the years since the two split, both have developed in the areas they were previously weak, Dunn told Pando's Sarah Lacy on the Southland stage this year. There's no right answer when it comes to the best way to build a business, as these two companies' varied routes illustrate. Here's betting that Spaly doesn't regret calling it a day at Trunk Club and that he'll be equally ecstatic should Bonobos one day ring the bell on Wall St. Nordstrom, of course, wins either way.